Overdraft Coverage: Uncovered

“If a consumer were to get a loan on those [overdraft fee] terms, that would equate to an annual percentage rate of over 17,000 percent.” – Director of the Consumer Financial Protection Bureau, Richard Cordray 7/31/14

It looks like overdraft fees are still a major source of income for banks, as well as a major source of fees for consumers.

In fact, of the revenue accumulated from fees associated with consumer checking as a whole, more than half comes from overdraft fees. In samplings of our own applicant data at Earnest, we see that around 80% of all fees charged to consumer checking accounts result from overdraft and insufficient funds charges.

What is an overdraft fee?

Overdraft fee – A charge that happens when banks allow their customers to “go negative” in their checking account when they draw funds beyond their balance, whether at an ATM or a store with their debit card, or even at a teller inside the bank itself.

For banks that charge consumers who overdraft, business is booming, bringing in over $30 billion per year.

When compared to short-term high interest rate loans, overdraft fees carry astronomical interest rates, since the amount of the “loan” needed is usually quite small and is usually paid back within days. Richard Cordray, the Director of the CFPB, has also compared these fees to loan interest charges: “The result is that some consumers are essentially paying $34 – which is the typical overdraft fee – to have the bank spot them less than $24 for just a few days. If a consumer were to get a loan on those terms, that would equate to an annual percentage rate of over 17,000 percent.”

Thanks to a 2009 law, financial institutions have to obtain consent from account holders to charge fees for this “protection” on ATMs and point-of-sale debit card transactions. This is called an “Opt-in”.

In what ways might I be “opted-in”?

You’ve probably seen opting-in called a different name: “overdraft coverage” or “overdraft protection”. Here is what they mean:

Opt-in – overdraft protection – The bank will automatically transfer funds over from a linked account (usually savings) to cover a transaction. A fee still applies, but it’s usually much lower (about $10-$12 per instance).

Opt-in – overdraft coverage – The bank can choose to process transactions with insufficient funds, but charge an overdraft fee for the convenience, meaning your debit card won’t be declined at the register, but you will face a hefty fine.

“Overdraft coverage” protects you from having your card declined – it does NOT protect you from getting hit with an overdraft charge. With overdraft coverage, you could easily find yourself paying for a “$40 latte” if your balance was at a couple dollars prior to the purchase.

Should I opt-out – and is it better?

The good news is that you do not have to sit by and let overdraft charges accumulate — you can “opt out”. When you opt out, debit purchases that would have resulted in a negative balance are simply rejected at the point of sale, meaning no fee, but also no purchase. Keep in mind that bounced checks and recurring automatic payments could still cause a fee. If you have a high savings account balance and your bank doesn’t charge for overdraft protection, then it might be reasonable to stick with that. For those with a low cushion of savings to draw from, or who use a bank that has an unsavory overdraft policy, it is probably worth it to opt-out.

Every bank is different, and not all overdraft policies are created equal. Whether overdraft protection is worth it comes down to your bank’s policies, coupled with the amount of savings that can be transferred cheaply to cover overdrafts. In March 2015 banks with over $1B in assets will have to start disclosing how much fee income they receive from overdraft fees, so in the future, consumers can hopefully shop around and understand which banks are truly fee harvesters.

What is my bank’s overdraft policy, and how do I opt out?

Considering that these fees are mostly ‘voluntary’ — meaning customers have actually “opted-in” to paying these charges — consumers should be aware that they can turn off this feature if they’re unhappy with it. Below, we have listed the overdraft information page for a handful of the largest banks. Click through to opt out, if available. Know your rights by visiting the Federal Reserve’s policies on overdraft fees page. Read your bank’s policy carefully, and keep in mind that if you are in need of short-term funds, there are better options available than 17,000% APR “loans”.